OSFI seeks public input on beefing up homebuyers stress tests

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OSFI is investigating a number of additional measures to mitigate rising credit risks

Released on January 12, 2023 • Last updated on January 13, 2023 • 4 minutes read

7 comments Mortgage lending risks are increasing as rising interest rates make payments more difficult for households already struggling with high levels of debt. Mortgage lending risks are increasing as rising interest rates make payments more difficult for households already struggling with high levels of debt. Photo by Tyler Anderson/National Post

Canada’s top banking regulator is asking the public for comment on whether it should step up “stress tests” imposed on homebuyers as rising interest rates make mortgages more onerous for households already struggling with heavy debt burdens.

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The Office of the Superintendent of Financial Institutions (OSFI) is seeking advice on whether to adopt a set of proposed complementary debt serviceability measures, including stress tests on interest rate affordability, loan-to-income and debt-to-income limits, and debt-service coverage limits.

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Since the introduction of Guideline B-20, which includes the mortgage stress test, in 2012 and the addition of new thresholds in 2018, “Conditions in the Canadian residential mortgage market have changed significantly,” OSFI said in a statement in which the consultation was announced.

“Mortgage credit risks, particularly those related to debt service ability, have increased significantly since the pandemic began. These heightened short-term risks underscore the need to consider complementary measures to mitigate them.”

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Currently, the mortgage stress test sets the qualifying minimum interest rate for an uninsured mortgage at the greater of the contract rate plus two percent, or 5.25 percent.

OSFI said it may choose to pursue one or more of the proposed actions to meet its regulatory policy goals based on the feedback it receives when considering revisions to Guideline B-20.

Submissions are possible until April 14th.

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“Basically, OSFI wants to remove another layer of the least qualified borrowers from the federally regulated mortgage market,” said mortgage analyst and strategist Rob McLister. “But how they’re going to do that isn’t clear yet.”

McLister said he doesn’t expect any changes that would give the housing market “time to digest high interest rates and rising unemployment” until around the third quarter of this year.

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Changes being considered by OSFI include new interest rate stress tests. The regulator noted that adjustable-rate and short-term mortgages can carry “increased” payment and rollover risks, so it might make sense to tighten the “affordability” test for these mortgages while making it easier to qualify for longer fixed-term mortgages with less risk .

OSFI is also considering whether lenders should use the qualifying minimum interest rate on non-mortgage debt rather than the actual interest rate when calculating a borrower’s ability to service total debt.

Another proposal on the table is new credit-to-income and debt-to-income limits, such as B. Setting an overall limit on the amount of the mortgage based on the borrower’s income. For example, the regulator could tell financial institutions not to dedicate more than 25 percent of their mortgage book to borrowers with a credit-to-income ratio of 450 percent or more, McLister said.

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The percentage of mortgage holders in that basket has risen from 14 percent to 26 percent, and he noted that the type of restrictions OSFI proposed to address this trend are favored by former Canada Mortgage and Housing Corp. chief executive Evan Siddall would.

New debt-service caps are also being considered, which could include tiered or tiered gross and total debt service caps, an explicit amortization limit for the debt-service cap calculation, and potential new capital constraints on mortgages with high debt-service ratios. OSFI is also considering tweaking the definitions and formulas used to calculate gross and total debt service, potentially to align with what is used for insured mortgages.

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Economists and bankers believe mortgage delinquencies will only become a major problem if unemployment rises sharply, as Canadians have historically cut household spending elsewhere to keep paying for their homes. However, if selling becomes the only option, the drop in home prices would complicate the picture for cash-strapped Canadians, as mortgage debt could be close to or even above what the property can fetch.

McLister noted that average Canadian home prices have fallen 22.4 percent over the past nine months as the Bank of Canada raised the overnight interest rate to 4.25 percent from a record low.

OSFI said the tweaks it is considering to curb the amount of debt homebuyers can take on would limit potential lender losses and reduce the likelihood of borrower defaults “by making ongoing debt payments more manageable.”

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The regulator said the existing stress test gave homeowners a cushion when interest rates rose last year, but that built-in cushion has been reduced.

“Recent hikes in mortgage rates have already eroded a significant portion of the debt-servicing capacity provided by the qualifying rate buffer, and debt-servicing ratios are still rising,” OSFI said.

“In a rising interest rate environment, debt service burdens increase as consumers pay more interest, which can have a significant impact, particularly on households that are already financially strained. This in turn can lead to higher failure rates.”

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